Monday 22 April 2019

Where now for FBD as Fairfax cashes out?

FBD boss Fiona Muldoon said Fairfax’s decision to cash out doesn’t represents a negative judgement on the Irish insurance market
FBD boss Fiona Muldoon said Fairfax’s decision to cash out doesn’t represents a negative judgement on the Irish insurance market

Comment: Dan White

With Fairfax after taking its money off the table what does the future now hold for FBD, the last remaining Irish-owned insurer? Last Monday FBD announced that it had agreed to repurchase the €70m of convertible notes which it sold to Canadian investment firm Fairfax in 2015. It has been a sweet deal for Fairfax.

Not alone did the notes pay an annual coupon or interest rate of 7pc, FBD is paying a €16m premium, ie a total of €86m, to buy them back. This means that the notes have yielded Fairfax an annual return of more than 12pc. Nice work if you can get it.

This is not the first time that Fairfax has made a killing investing in Irish financial shares. In 2011 it pumped €300m into Bank of Ireland as part of the deal that kept Ireland's oldest bank out of majority state ownership. By the time Fairfax had offloaded most of its Bank of Ireland shares six years later it had almost trebled its money.

So why did FBD pay a premium to repurchase the notes? With FBD haemorrhaging cash - it recorded an €85m pre-tax loss in 2015 - and regulators demanding that it raise extra capital, Fairfax was able to drive a hard bargain three years ago. In addition to the 7pc coupon, the notes were convertible into shares if the FBD share price stayed above €8.50 for 180 days after September 23 of this year.

With the FBD share price trading at just over a tenner before the repurchase announcement, it was virtually certain that the notes would be converted next March. This would have resulted in Fairfax receiving 8.23 million new shares, giving it a 19pc stake in FBD. The issue of the new shares would also have diluted FBD's existing shareholders. The IFA-linked Farmer Business Developments and FBD Trust, which between them own 32.5pc of FBD's shares would have seen their combined stake diluted to 26.8pc.

FBD has already fended off several unwanted takeover approaches, most notably in 2008 when Dutch financial services group Eureko was reported to be offering up to €36 a share (€1.2bn for the entire company).

Repurchasing the notes, rather than letting Fairfax convert them into shares, rules out the possibility of a predator being able to acquire a ready-made large shareholding in FBD, which could then be used as a platform from which to launch a hostile bid.

"There would have been a big overhang [of shares] if Fairfax had converted," said Davy analyst Diarmaid Sheridan.

FBD is funding the repurchase of the €50m of notes with a 5pc coupon and €36m of cash from its own resources.

The Irish insurance sector has been through hell and back in recent years. Soaring claims costs pushed all of the major players, including FBD, deep into the red. This in turn pushed up premiums as the insurers sought to recover their losses. Motor insurance was particularly badly hit, with average premiums jumping by a cumulative 68pc in the three years to August 2016.

However, the cycle seems to have turned recently with average motor premiums falling by a cumulative 19pc in the two years to August 2018. But is this as good as it gets? By not converting and taking its money off the table is Fairfax calling the top of the market?

"The Fairfax business model is one where they either take full control or make a tactical investment, where they take a return as happened in the case of Bank of Ireland," said Sheridan.

"This was purely a financial investment rather than an operational one."

After the heavy losses incurred in 2015 FBD is now firmly back in the black. Pre-tax profits recovered to almost €50m in 2017 and jumped by 50pc to €18.4m in the first half of 2018. The company resumed paying dividends to its shareholders in 2017 after a two-year gap.

FBD boss Fiona Muldoon doesn't believe that Fairfax's decision to cash out represents a negative judgement on the Irish insurance market.

"They [Fairfax] do it in partnership with the companies they invest in. They are happy with their return. They were happy to work with the company. It is something that suits us. It suits our largest shareholder. It reinstates us to where we were before 2015.

"All of the institutional shareholders like the fact that the transaction avoids dilution. It also allows us to refinance at a lower coupon."

The prospect of the dilution that would have resulted from a major issue of new shares to Fairfax has been holding the FBD share price back in recent months. Following the repurchase announcement the FBD share price jumped by over 6pc to €10.80.

Shore Capital analyst Paul De'Ath describes the repurchase as "a neat solution to dilution".

However, while motor insurance premiums have fallen from their 2016 highs, the cost of other forms of insurance is still rising. Home insurance is up by a further 3.5pc in the year to August and by a cumulative 22pc over the past four years.

"Insurance has been a cyclical business ever since they first rang the bell at Lloyd's over 300 years ago," says Muldoon. However, with the EU's Competition Directorate investigating Irish motor insurance premiums, Muldoon, like many insurance bosses, is naturally cautious about commenting on insurance prices.

At one stage there were several Irish-owned insurance companies. Since the 1980s they have all, with the exception of FBD, fallen by the wayside and the market is now largely dominated by foreign-owned companies. Doesn't this make FBD something of an anomaly?

"I would prefer unique," says Muldoon. "I think that we can carve out a viable path as an Irish-owned insurance company." FBD has recently announced the sponsorship of Ireland's team at the 2020 Olympics in Tokyo, a move Muldoon believes will help emphasise FBD's Irishness.

FBD's core market remains the farming community, from which it still draws approximately one-third of its business. Its other main sources of business are consumer motor (25pc), small business (17pc), commercial motor (15pc) and home insurance (10pc).

Muldoon characterises FBD as being a "three-legged stool" consisting of farm, motor and SME business.

The repurchase has led most analysts to rejig their FBD profit forecasts. This year's profits will take a €16m hit due to the premium paid to Fairfax while going forward there will be the €2.5m annual cost of servicing the new notes - the consensus among analysts had been that the 2015 notes would be converted into shares that would have entirely eliminated the €4.9m annual cost of servicing them from next March.

Shore's De'Ath has cut his 2018 profit forecast from €36.9m to just €20.1m and his 2019 forecast from €37.6m to €34.7m. However, as the notes have been repurchased rather than converted, there will be almost 20pc fewer FBD shares than had previously been anticipated. This means that, at the same time as profits will be lower than expected, earnings per share (basically after-tax profits per share) will be higher than previously expected.

De'Ath reckons that EPS will be 26 cent rather than 23 cent in 2019 and 32 rather than 29 cent in 2020.

"This is a good transaction of management, staff and shareholders. The 5pc coupon [on the new notes] shows how far we have come over the past three years," says Muldoon.

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